Private Credit

Also known as: Direct lending, Private debt

The shadow banking success story: funds replaced banks as lenders to the buyout world, and kept growing.

4 min read · 709 words · Updated

1 · SnapshotThe one idea to remember
Key intuition: private credit moved bank lending onto pension-fund balance sheets — same borrowers, higher rates, longer lockups, and a risk record still being written.
2 · BeginnerWhat is it, really?

Private credit is lending done by funds instead of banks. A fund manager collects money from pensions and insurers, then goes to a company and negotiates a loan with it directly. The borrowers are usually mid-sized firms, and usually ones a private equity fund already owns. Banks used to make these loans. After the rules were tightened following 2008, they largely stopped wanting to.

The loans pay a floating rate: a benchmark rate that moves with central-bank rates, plus another 5–7% on top. They rank ahead of other lenders if things go wrong, and they come with real conditions the borrower has to keep meeting. In recent years that has added up to 10–12% a year, which is why so much money went in. Fifteen years ago this was a corner of the market. It is now a mainstream way for a company to borrow, and in some parts of the market the biggest managers — Apollo, Ares, Blackstone — lend more than the banks do.

Three things are given up in exchange. You cannot sell: there is barely any second-hand market for these loans. You cannot check the price: nobody trades them, so the value you are shown is the lender's own estimate. And you cannot look up the track record, because there isn't a full one. The industry has never been through a proper wave of defaults at anything like today's size, so how much is really lost when things turn is still an open question.

One lender, one borrower, no market in between
The credit fundthe lenderThe borrowera private companyThe fund's investors2The loan, drawn in full3Floating interest, plus awide margin5Interest paid in kind, notcash1Capital, called as needed4Distributions, less fees6No market price, at any point

a paymentsomething deliveredonly if a condition is metnot a payment

There is no syndicate, no rating and no screen price. The value of the loan is whatever the lender's own model says.

At the start

  1. The fund's investors → The credit fund The fund draws money from its investors to make each loan.
  2. The credit fund → The borrower Negotiated bilaterally: the covenants, the rate and the security are agreed between two parties and disclosed to nobody else.

Every quarter

  1. The borrower → The credit fund The borrower's cost rises with policy rates. Whether it can afford the higher payment is the question the asset class turns on.
  2. The credit fund → The fund's investors Paid through to investors.

If the borrower struggles

  1. The borrower → The credit fund The unpaid interest is added to the principal instead. Income keeps being reported while no money is arriving — which is why the proportion of it is worth watching.

What is missing throughout

  1. The credit fund → The fund's investors The loan is marked by the manager. A stable reported value is a statement about the marking, not evidence about the loan.
Asset class
Private markets (debt)
Instrument type
Directly negotiated loans / fund stakes
Traded
Not traded; hold to maturity
Typical users
Insurers, pensions, BDC shareholders

Which risks decide the outcome

Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.

  • Marketmatters
  • Creditdecides it
  • Liquiditydecides it
  • Fundingmatters
  • Operationalmatters

What decides it here. There is no market price at any point: the loan is marked by the manager. Interest paid in kind keeps income being reported while no money is arriving.

What the five mean, and which one decides where →

3 · IntermediateHow it works in practice

The product shelf

  • Direct lending: senior secured loans to mid-market/sponsor-backed firms — the core.
  • Unitranche: one blended facility replacing senior + mezzanine — simpler, bigger, the signature instrument.
  • Mezzanine/junior, special situations/distressed, asset-based finance (receivables, equipment, royalties — the current growth frontier), and NAV lending to funds themselves.
  • Wrappers: drawdown funds for institutions; BDCs (listed, US) and semi-liquid evergreen funds for private wealth — the retail frontier, with liquidity promises worth reading twice.

Why borrowers pay up

Speed and certainty (one lender, no syndication risk), confidentiality, covenant flexibility negotiated bilaterally — worth 100–300bp over syndicated markets to a sponsor closing a deal. The lender's edge: origination relationships and workout control when things sour.

The questions that matter now

Floating rates transferred rate risk to borrowers — interest coverage ratios compressed sharply post-2022. Payment-in-kind (PIK) toggles and amend-and-extend activity are the stress indicators to watch; marks lag reality by construction, and the recovery assumptions (~70%, bank-loan-like) are untested at asset-class scale.

Worked example: unitranche at SOFR+600, SOFR at 4.5% → 10.5% coupon. Levered loan fund (0.5x fund leverage at SOFR+250) nets LPs ~12% while defaults stay ~2% with 60% recovery — and ~6% if defaults run at 8% with 45% recovery. The same portfolio; the cycle decides which line you get.
4 · AdvancedPricing & valuation

Valuation without markets

Loans are marked quarterly to "fair value" via matrix pricing: benchmark spread movements + borrower-specific credit assessment, overseen by valuation agents. The smoothing is structural — BDC marks trailed the 2022 syndicated-loan selloff by two quarters and half the amplitude. Analysis must therefore run on look-through fundamentals: portfolio interest coverage, fixed-charge coverage, PIK share, non-accruals, and vintage concentration.

Return decomposition

$$ r_{LP} \approx \underbrace{(SOFR + s)}_{\text{coupon}} + \underbrace{f_{OID}}_{\text{fees/points}} - \underbrace{\lambda(1-R)}_{\text{expected loss}} - \underbrace{c_{mgmt+carry}}_{\text{fees}} + \underbrace{L(r_{asset} - r_{debt})}_{\text{fund leverage}} $$
What the symbols mean
  • rthe interest rate, per year
  • Lleverage, or a loss given default
  • Pa price, or a present value
  • Sthe price of the underlying today
  • Fthe forward or futures price
  • Ra return

The debated term is \(\lambda(1-R)\): observed defaults have been benign, but the borrower cohort (small, levered, sponsor-owned, recession-untested) resembles high-yield's riskier half. Sceptics price the spread as illiquidity + complexity premium; enthusiasts as banking's abandoned margin. Both are partly right; the cycle will apportion.

Systemic angle

Regulators (Fed, BoE, IMF) now map bank exposure to private credit funds (subscription lines, fund leverage, insurer stakes) — the risk moved off bank balance sheets but is tethered back through financing. Insurance-owned managers matching illiquid credit to annuity liabilities (the Apollo/Athene template) are the structural innovation being stress-watched.

The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.

5 · Desk notesHow practitioners think about it
Practitioner note: in private credit the metric that matters is not yield but loss-adjusted, fee-adjusted spread per unit of illiquidity — and the diligence that matters is the manager's workout record, because in this asset class the lender IS the recovery rate.

Now say it back

Close the page and give Private Credit in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.

  1. Who wants what — two parties wanted opposite things badly enough to write it down.
  2. What the contract obliges, and when — not the payoff; the obligation.
  3. Where the money comes from — name the source, or you have described a hope.
  4. What makes it lose — the ordinary way, not the dramatic one.

Do it with a clock → · why these four

Put Private Credit beside any other instrument →

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Where this instrument shows up elsewhere

  • MediumPrivate CreditIndustryLending directly to companies, without a bond market in between — and holding the loan rather than distributing it
  • MediumWhat is private equity?QuestionsBuying whole companies with borrowed money, improving something, and selling in five years
  • MediumWhich Desk Trades WhatPrepEleven trading seats and six that sit next to them: what each one actually touches, the single number it lives by,…
  • HardSecondariesIndustryBuying a fund stake from somebody who wants out before the fund ends — pricing an asset whose value is an opinion

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